Not so fast on the great rotation

The much-ballyhooed great rotation out of fixed-income assets and into riskier equities has not exactly lived up to its greatness.
After a month of record inflows ($86 billion) to open-end mutual funds in January, investors continued to put money into the markets — a still strong $52 billion last month, according to Morningstar Inc.’s flow data. But they aren’t rotating into U.S. equities with any conviction.
After investors plowed more than $15 billion into U.S. stock funds in January —perhaps the first indication of a rotation out of low-yielding bonds and into undervalued stocks — the flow dipped to just below $2 billion in February.
That is a reversal from the outflows those funds experienced for all of last year, but not a very big one.
“We’re just not seeing the great rotation,” said Morningstar fund analyst Michael Rawson. “In January, there were massive flows going everywhere. That moderated in February, but not much of it is going into U.S. equities.”
Where it’s going is into international stocks. Investors put $16.5 billion into the international stock fund category, with the diversified emerging-markets sub-category being the single most popular area ($6.2 billion in inflows). The international stock category has taken in just under $35 billion in the first two months of 2013 — one reason some emerging-markets equity funds are closing to new investors.
Investors also appear to be looking to take on more risk, not with stocks but with their fixed income investments. Another $18.6 billion flowed into taxable bond funds, but the lion’s share of it went into non-traditional, and arguably more risky sectors of the market.
The three leading fixed-income subcategories in terms of flows last month were bank loan, nontraditional-bond, and world bond funds — all of which attracted more than $5 billion in inflows. The intermediate-bond-fund category, which has attracted hundreds of billions in inflows over the past few years, took in less than $2 billion in February; intermediate government bond funds saw $2.4 billion in outflows.
“Within fixed income, investors are withdrawing from the safer assets and putting money into traditionally more risky areas,” said Mr. Rawson. “Of course, in this environment [with the potential of rising rates], they may not necessarily be riskier.”
What is clear is that investors are not quite ready to unwind their bond investments and shift wholeheartedly into U.S. stocks, despite several benchmark indexes setting new records. Through Wednesday, the Dow Jones Industrial Average had chalked up nine-straight record closes.
“I expect over the next three years to see more money going into to stocks, but for now, the great rotation is a straw man,” said Mr. Rawson, who suggested the recent rally in U.S. stocks may be keeping investors cautious. “It’s a concept that people are talking about, but we’re not yet seeing.”